Seven Weeks of Gains, Seven Equity Themes | Bob Doll

Great market summary from Bob Doll at Nuveen Asset Management:

  1. Economic data remains strong and hurricane effects have been surprisingly muted. Real third quarter gross domestic product was reported to be 3.0%, with nominal growth hitting 5.2%. Both numbers came in higher than expected, with nominal growth reaching its strongest pace since 2006.
  2. Home sales are increasing, demonstrating that economic growth remains broad. New home sales hit their highest level since 2007.
  3. The Federal Reserve is on track to increase rates again in December. We expect the central bank will enact its third hike of the year, while continuing to reduce its balance sheet. Fed policy remains accommodative, but is clearly normalizing.
  4. Corporate earnings are on track for another strong quarter. We are past the halfway point of reporting season, and the vast majority of companies have beaten expectations. On average, companies are ahead of earnings growth expectations by 4.9%.
  5. Stock buybacks appear to have slowed, but companies are still deploying cash in shareholder-friendly ways. From our vantage point, we are seeing companies pour more resources into hiring and modest amounts of capital expenditures.
  6. Tax reform prospects still appear uncertain, but we have seen progress on the regulatory front. While President Trump has struggled to enact his pro-growth legislative agenda, he has had success in rolling back regulatory enforcement. The financial and energy sectors in particular appear to be benefiting from less scrutiny.
  7. It is possible that tax reform will focus on corporate rather than individual rates. The most controversial aspects of tax reform are focused on possible changes to individual tax rates (such as arguments over the deductibility of state and local taxes). In contrast, corporate tax reform appears less controversial, as Congress seems to have broad agreement on the need to reduce corporate taxes and solve the issue of overseas profits. While still a small probability, Republicans may choose to separate the two issues and proceed solely on a corporate tax bill.

Economic growth remains muted but earnings are exceeding expectations. High levels of stock buybacks in the last few years must be playing a part.

Rising home sales are a bullish sign.

The Fed remains accommodative for the present but I expect increasing inflationary pressure to temper this next year.

Slow rates of investment remain a cause for concern and could hamper future growth — buybacks are cosmetic and won’t solve the low growth problem in the long-term.

Corporate tax reform would be a smart move, creating a more level playing field, while avoiding the acrimony surrounding individual tax rates.

Stage 3 of the bull market continues…..

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Fed flunks econ 101: understanding inflation | MarketWatch

Caroline Baum’s opinion on the Fed’s approach to inflation:

For all the sturm und drang about the Fed debasing the dollar and sowing the seeds of the next great inflation, the public’s demand for money has increased. The increased desire to hold cash and checkable deposits has risen to meet the increased supply. Velocity, or the rate at which money turns over, has plummeted.

The Fed has two choices. It can adopt the Dr. Strangelove approach and learn to stop worrying and live with low inflation and low unemployment. Or it can do something about it, which runs counter to its stated intention to raise the funds rate and reduce the size of its balance sheet.

Option #1 involves learning to live with a low, stable inflation rate about 0.5 percentage point below the Fed’s explicit 2% target.

Not only has the Fed has achieved price stability in objective terms, but it has also fulfilled former Fed Chairman Alan Greenspan’s subjective definition of price stability: a rate of inflation low enough that it is not a factor in business or household decision-making.

Option #2 means taking some additional actions to increase the money supply by lowering interest rates or resuming bond purchases. The Fed is taking the opposite approach. It began its balance sheet normalization this month, allowing $10 billion of securities to mature each month and gradually increasing the amount every quarter. And it has guided markets to expect another 25-basis-point rate increase in December….

The Fed faces a delicate balancing act. Unemployment is low but capacity utilization is also low, indicating an absence of inflationary pressure.

Capacity Utilization

Janet Yellen understandably wants to normalize interest rates ahead of the next recession but she can afford to take her time. The economy is unlikely to tip into recession unless the Fed hikes rates too quickly, causing a monetary contraction.

I believe the Fed chair is relying on the outflow from more than $2 trillion of excess reserves held by banks on deposit with the Fed to offset the contractionary effect of any rate hikes.

Capacity Utilization

If pushed, the Fed could lower the interest rate paid on excess reserves in order to encourage banks to withdraw excess deposits. But so far this hasn’t been necessary. The attraction of higher interest rates in financial markets has been sufficient to encourage a steady outflow from excess reserves, keeping the monetary base (net of reserves) growing at a steady clip of close to 7.5% p.a. despite rate hikes so far.

Capacity Utilization

Inflation is always and everywhere a monetary phenomenon. ~ Milton Friedman

Makes you wonder why Donald Trump would even consider replacing the Fed chair when she is doing such a great job of managing the recovery.

Source: Fed flunks econ 101: understanding inflation – MarketWatch

Gold tanked? Not yet!

Gold broke below its recent flag formation, warning of a test of support at $1200/ounce.


Selling is driven by expectations of a Fed interest rate hike in June …..and recent Chinese stimulus which postponed Yuan devaluation against the Dollar. But expectations of a rate hike are causing a sell-off of the Chinese Yuan, with the USDCNY strengthening over the last few weeks.


…Which in turn will cause the Chinese to sell foreign reserves to support the Dollar peg (…..else devalue which would panic investors and cause a downward spiral). Sale of Dollar reserves by China would drive the Dollar lower.

Dollar Index

…and Gold higher. I remain bullish as long as support at $1200/ounce holds.

Disclosure: Our Australian managed portfolios are invested in gold stocks.

Lighting a fuse

The Fed quit quantitative easing more than a year ago, limiting total assets on its balance sheet to $4.5 trillion. But more than $2.5 trillion of cash injected into the financial system had been deposited straight back into the Federal Reserve system by banks as excess reserves, earning 0.25% p.a.

Fed Total Assets and Excess Reserves

Fresh money continued to leak into the financial system as banks drew down their excess reserves, highlighted above by the widening gap between Total Assets and Excess Reserves. In December 2015 the Fed doubled the rate payable on excess reserves to 0.50% p.a. The intention is clearly to attract more excess reserves and narrow the gap, or at least slow the rate at which excess reserves are being withdrawn to prevent further widening.

Easy money policies followed by central banks around the world are not achieving the desired result of reviving business investment. If we examine the Fed’s track record over the last two decades, sharp surges in business credit were accompanied by speculative bubbles — stocks ahead of the Dotcom crash and housing ahead of the GFC — with disastrous results. GDP failed to respond.

Business Credit Growth v. Nominal GDP

The latest rally in global markets is also driven by monetary easing, this time in China, with a massive surge in the money supply signaling PBOC intentions to print their way out of trouble (and into an even bigger hole).

Ineffectiveness of monetary policy in solving structural problems has often been described as “like pushing on a string”. But recent experience shows it is more like lighting a fuse.

This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life …. and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.

~ John Maynard Keynes: The Great Slump of 1930

Coppola Comment: Creeping nationalisation

From Frances Coppola:

…the super-safe backstop offered to money funds by the Fed is only the latest in a long line of implicit government guarantees propping up the financial system. Far from ending government support of the financial system, the developments of recent years have actually made it MORE dependent on the state.

Markets, too, have become government-dependent. Markets watch central banks all the time, anticipating their actions and responding to their announcements. And exceptional monetary policy by central banks has impacted market functioning. QE reduced the supply of safe assets, raising their price, while the additional money flowing into markets as a result of QE blew up bubbles in various other classes of asset, both safe assets gold, commodities, fine art and above all real estate and high-yield assets. It is hard to say what market prices would be like now if no central bank were doing QE, and we are unlikely to find out any time soon: the US is withdrawing QE, but Japan is currently doing the largest QE programme it has ever done and the ECB may also soon be forced reluctantly to do some form of asset purchase programme. China has been doing yuan QE for a while, but if dollar liquidity becomes an issue it may be forced to repo out its USTs, which would reinforce the Fed’s ONRRPs and make control of dollar liquidity more difficult. And of course the Swiss have been quietly controlling the Swiss franc market for ages. To prevent the Swiss franc rising, they’ve done the largest QE programme in the world relative to the size of their economy….

Read more at Coppola Comment: Creeping nationalisation.

The last two times the Fed has ended a period of quantitative easing, the air has come out of the market balloon. Has this coming move been so telegraphed that the reaction will be different than in the past, or will we see the same result? Want to bet your bonus on it? Or your retirement?

~ John Mauldin

See graph at Mauldin Economics

John Mauldin: Effect of the taper

Impact of QE (or lack thereof) is reflected by excess reserves

JKH at Monetary Realism writes:

….there is a systematic tendency in the blogosphere and elsewhere to misrepresent the impact of QE in a particular way in terms of the related macroeconomic flow of funds…… Most descriptions will erroneously treat the macro flow as if banks were the original portfolio source of the bonds that are being sold to the Fed, obtaining reserves in exchange. This is not the case. A cursory scan of Fed flow of funds statistics will confirm that commercial banks are relatively small holders of bonds in their portfolios, especially Treasury bonds. The vast proportion of bonds that are sold to the Fed in QE originate from non-bank portfolios……. Many descriptions of QE instead erroneously suggest the strong presence of a bank principal function in which bonds from bank portfolios are simply exchanged for reserves. In fact, for the most part, while the banking system has received reserve credit for bonds sold to the Fed, it has also passed on credits to the accounts of non-bank customers who have sold their bonds to the banks. This is integral to the overall QE flow of bonds.

There is a simpler explanation of what happens when the Fed purchases bonds under QE. Bank balance sheets expand as sellers deposit the sale proceeds with their bank. In addition to the deposit liability the bank also receives an asset, being a credit to its account with the Fed. Unless the bank is able to make better use of its asset by making loans to credit-worthy borrowers, the funds are likely to remain on deposit at the Fed as excess reserves — earning interest at 0.25% per year. Excess reserves on deposit at the Fed currently stand at close to $1.8 trillion, reflecting the dearth of (reasonably secure) lending/investment opportunities in the broader economy.

Read more at The Accounting Quest of Steve Keen | Monetary Realism.

SCHIFF: The Great Reflation | Business Insider

Peter Schiff writes:

The truth is that most buyers cannot afford today’s prices without the combination of government guarantees and artificially low mortgage rates. The Federal Reserve has been conducting an unprecedented experiment in economic manipulation. By holding interest rates near zero and by actively buying more than $40 billion monthly of mortgage-backed securities and $45 billion of Treasury bonds, the Fed has engineered the lowest mortgage rates in generations.

Read more atSCHIFF: The Great Reflation – Business Insider.

J.P. Morgan, Goldman Get a Dose of Fed’s Reserve |

David Reilly reports on the Fed’s latest stress tests:

The passes show how far big U.S. banks have come since the financial crisis. But capital levels seen under the tests, and taking into account the capital-return plans, weren’t especially strong. Tier 1 common ratios for J.P. Morgan and Goldman, for example, were only marginally above the 5% minimum needed.

What’s more, leverage ratios including capital returns are particularly thin: Of the six biggest banks, four had ratios below 5%. While above the test’s 3% minimum, such levels wouldn’t give banks tremendous room to maneuver in a crisis.

The leverage ratios are particularly telling because they don’t allow for risk-weighting of assets. That approach is coming under increased criticism for potentially allowing banks to mask the true level of risk on their books.

Read more at HEARD ON THE STREET: J.P. Morgan, Goldman Get a Dose of Fed's Reserve –

Cause of the 2007/8 crash and threatened double-dip in 2010

Here is the smoking gun. Note the sharp contraction in the US monetary base before the last two recessions and again in 2010. Monetary base (M0) is plotted net of excess bank reserves on deposit with the Fed, which are not in circulation. The Fed responded after the contraction had taken place, instead of anticipating it.

Monetary Base minus Excess Reserves

The long-term problem is that the monetary base should not be expanding at 10 percent a year. More like 3% to 5% — in line with real GDP growth.

Risk Seen in Fed Bond Buying |


The Federal Reserve should stop buying bonds, even as the central bank is poised to purchase more, according to a narrow majority of economists in a new survey by The Wall Street Journal……”It’s distorting market prices and creating problems in the future,” said John Silvia, chief economist at Wells Fargo Securities, who said the Fed’s bond-buying was making long-term Treasurys too expensive without significantly easing problems in the labor market. “The Fed needs to back away and let interest rates rise just a little bit,” he said.

If past performance is anything to go by, Fed quantitative easing (or bond buying) is ineffectual in lifting the employment rate. And the lower that they drive bond yields, the greater the backlash when yields eventually rise. Yields are likely to spike up rapidly as bond-holders attempt to offload positions in order to avoid massive capital losses.

via Risk Seen in Fed Bond Buying –

Fed’s numerical thresholds are a bad idea

The Fed effectively tied its monetary policy to a balloon bobbing in the wind. Pedro da Costa writes on Reuters:

The Federal Reserve on Wednesday took the unprecedented step of tying its low rate policy directly to unemployment, saying it will keep rates near rock bottom until the jobless rate falls to 6.5 percent. That’s as long as inflation, the other key parameter of policy, does not exceed 2.5 percent.

Both unemployment and inflation are moving targets. Unemployment primarily because results are highly dependent on the participation rate: disheartened job seekers who give up looking for work are excluded from unemployment figures. Likewise, inflation measures are highly subjective. Weightings require constant adjustment because of advances in technology and changes in consumption patterns, while cost of housing estimates, which make up 39 percent of core CPI, seem to have little connection with reality. Scott Sumner points out:

The problem seems to be that, according to the Bureau of Labor Statistics, housing prices did not fall. On the contrary, their data shows housing prices actually rising between mid-2008 and mid-2009, despite one of the greatest housing market crashes in history. And prices did not rise only in nominal terms; they rose in relative terms as well, that is, faster than the overall core CPI. If we take the longer view, the Bureau of Labor Statistics finds that house prices have risen about 8 percent over the past six years, whereas the famous Case-Shiller house price index shows them falling by nearly 35 percent…..

The Fed’s interest rate policies are damaging rather than restoring confidence and should be reversed

Vince Foster at The Fiscal Times writes about this Wednesday’s FOMC meeting:

With Operation Twist due to expire at the end of the year and because the Fed is essentially out of short-term bonds with which to finance purchases, it is virtually assured that they will opt for outright purchases financed with printed money……….Now, said Ned Davis Research in a report last week, the Fed is likely to replace Operation Twist with purchases of Treasuries, perhaps in the $45 billion a month range, bringing its total monthly purchases to $85 billion.

Outright purchases of long-term Treasuries are far more expansionary than Operation Twist purchases which are off-set by the sale of shorter-term maturities.

Foster discusses Fed motives, considering that previous QE failed to lower interest rates or lift stock market values.

It has been my contention that the main objective is not to reflate asset prices but rather to stimulate credit creation and the velocity of money. According the Fed’s H.8 Release banks are holding over $2.6 trillion in cash that’s sitting idle on their balance sheet in securities portfolios. Bernanke is trying to flush the banking system out of these bloated securities positions and into extending credit by lowering bond yields to levels where banks can no longer afford to hold them.

Foster points out that negative real interest rates may be discouraging banks from lending, inhibiting the recovery. Also that bank balance sheets — bloated with Treasuries and MBS ($2.6 trillion) purchased as an alternative to lending — are vulnerable to capital losses should interest rates rise.

The Fed’s low-interest-rate policies have created a powder keg while being largely ineffectual in stimulating credit creation and consumption. The safest approach would be to reverse these policies and raise interest rates. Raising long-term rates to sustainable levels would reduce uncertainty and help restore confidence. House prices and stocks may initially fall but this would flush any excess inventory out of the system, giving purchasers and banks confidence that the market really has bottomed. With higher rates and stable collateral, banks will be more willing to lend.

At present we are all sheltering under the shadow of the Fed’s low-interest-rate umbrella, but with a nagging fear as to what will happen when the Fed takes the umbrella away. Fed policies are no longer adding confidence but increasing uncertainty. The sooner the umbrella is removed, the sooner the system will return to normality.

QE is likely to continue — Treasury needs to print money in order to fund the fiscal deficit — but this can still occur at higher rates. The fiscal deficit unfortunately will remain with us for some time — until confidence is completely restored and deflationary effects of private sector deleveraging are consigned to the history books.

Read more at How the Fed Will Affect Economy, Market in 2013 | The Fiscal Times.

Fed set to unveil extra asset purchases –

Robin Harding at FT writes:

The other issue on the agenda is replacing the FOMC’s current forecast that rates will stay low until mid-2015 with a set of preconditions for the economy to reach before it considers raising rates. “I now think a threshold of 6.5 per cent for the unemployment rate and an inflation safeguard of 2.5 per cent . . . would be appropriate,” said Charles Evans, president of the Chicago Fed…..

The problem is that both of these thresholds are moving targets:

  • Unemployment is based on surveys and only includes those who have actively sought a job in recent weeks. It fluctuates with the participation rate.
  • Inflation is also subjective, dependent on the basket of goods measured and estimates of housing inflation that are subject to manipulation.

Targeting nominal GDP growth would be far more accurate.

via Fed set to unveil extra asset purchases –

Bernanke attempts to justify screwing savers

This extract from Joe Weisenthal lauds Ben Bernanke’s defense of monetary policy and its effect on savers.

I would encourage you to remember that the current low levels of interest rates, while in the first instance a reflection of the Federal Reserve’s monetary policy, are in a larger sense the result of the recent financial crisis, the worst shock to this nation’s financial system since the 1930s. Interest rates are low throughout the developed world, except in countries experiencing fiscal crises, as central banks and other policymakers try to cope with continuing financial strains and weak economic conditions.

He [Bernanke] then goes onto note that saving isn’t just “having money in a bank” and that the main way to benefit everyone (including savers) is to induce growth:

A second observation is that savers often wear many economic hats. Many savers are also homeowners; indeed, a family’s home may be its most important financial asset. Many savers are working, or would like to be. Some savers own businesses, and—through pension funds and 401(k) accounts—they often own stocks and other assets. The crisis and recession have led to very low interest rates, it is true, but these events have also destroyed jobs, hamstrung economic growth, and led to sharp declines in the values of many homes and businesses. What can be done to address all of these concerns simultaneously? The best and most comprehensive solution is to find ways to a stronger economy. Only a strong economy can create higher asset values and sustainably good returns for savers. And only a strong economy will allow people who need jobs to find them. Without a job, it is difficult to save for retirement or to buy a home or to pay for an education, irrespective of the current level of interest rates.

The way for the Fed to support a return to a strong economy is by maintaining monetary accommodation, which requires low interest rates for a time. If, in contrast, the Fed were to raise rates now, before the economic recovery is fully entrenched, house prices might resume declines, the values of businesses large and small would drop, and, critically, unemployment would likely start to rise again. Such outcomes would ultimately not be good for savers or anyone else.

In layman’s terms, Bernanke is saying that if the Fed didn’t act, everyone, including savers, would be in deep **** (trouble) …….so savers should be happy they are being screwed.

via Bernanke: Federal Reserve & Monetary Policy – Business Insider.

Fed to Buy More Bonds in Bid to Spur Economy –


After months of careful signaling, the Fed’s policy-making committee said it would buy $40 billion each month of agency mortgage-backed securities on an open-ended basis and said it could extend those purchases and buy additional assets if the job market doesn’t improve.

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved,” the Federal Open Market Committee said in a statement issued at the end of its two-day meeting.

via Fed to Buy More Bonds in Bid to Spur Economy –

I guess I was wrong about the Fed holding off until after the election.

Harry S Dent: Why the Fed will fail

Harry Dent is always entertaining to listen to, but is he right about the link between demographics and inflation?

There is simply no way the Fed can win the battle it’s currently waging against deflation, because there are 76 million Baby Boomers who increasingly want to save, not spend. Old people don’t buy houses! At the top of the housing boom in recent years, we had the typical upper-­‐middle-­‐class family living in a 4,000-­‐square-­‐foot McMansion. About ten years from now, what will they do? They’ll downsize to a 2,000-­‐ square-­‐foot townhouse. What do they need all those bedrooms for? The kids are gone. They don’t visit anymore. Ten years after that, where are they? They’re in 200-­‐square-­‐foot nursing home. Ten years later, where are they? They’re in a 20-­‐square-­‐foot grave plot. That’s the future of real estate. That’s why real estate has not bounced in Japan after 21 years. That’s why it won’t bounce here in the US either. For every young couple that gets married, has babies, and buys a house, there’s an older couple moving into a nursing home or dying.

In my opinion there is a clear link between credit growth and inflation: the faster credit grows, the faster the money supply grows, and the higher the rate of inflation. Demographics are one of the factors that drive credit growth, but they are not the only factor. Interest rates are just as important: when interest rates are low we tend to save less and borrow more. And jobs, as the Fed discovered, are also important: if you haven’t got a job, you can’t borrow from the bank even when interest rates are low.

At present I would guess that jobs are the biggest constraint on credit growth. Later, interest rates will rise when employment recovers — as the Fed attempts to take some of the heat out of the economy. Only then may demographics become the major restriction on credit growth, with older households down-sizing outnumbering younger households up-sizing. But that is by no means definite: solving the jobs crisis alone could take decades!

Harry dent quoted from John Mauldin | A Decade of Volatility: Demographics, Debt, and Deflation (application/pdf Object).